Both the June CPI and PPI came in hot and well ahead of expectations. There was the inevitable debate about the transitory nature of the price increases. Looking longer term, however, the conventional models for explaining inflation have been unsatisfactory. In the face of the apparent failure of these conventional models, we offer an alternative wage-based theory of inflation.
We conclude that the historic imbalance between capital and labour has become extremely stretched and the pendulum is swinging back. For investors, this presents a number of challenges as the returns to capital compress and inflation rises.
The conventional hedge against inflation is to buy shares of companies that can pass through price increases. This includes companies with strong branding or able to extract monopolistic profits, commodities and resource extraction companies in mining and energy. An unconventional and overlooked investment strategy is trend following, as outlined in a recent paper, “The Best Strategies for Inflationary Times”.
As a chartist, it’s easy to be bearish. After all, the market is experiencing numerous negative breadth divergences and signs of excessive bullish sentiment. Beneath the surface, however, the technical condition of the market can better be described a “glass half full or half empty” dilemma.
We continue to believe the market has bifurcated into two distinct markets — value and growth. In aggregate, it’s difficult to make much of a judgment about the direction of the S&P 500 owing to the divided nature of market internals. The internal rotation is continuing and value is poised to gain the upper hand.
Short-term breadth and sentiment readings indicate that a rebound is likely, but the bulls shouldn’t bring out the champagne just yet as the market could just be at the bottom of a trading range. Until we see a definitive bullish or bearish catalyst, our base case calls for a sideways market with a possible minor upward bias.